North American Life Insurers "Accidentally" Pile Up Massive Distressed Debt Holdings

Accommodative monetary policy by the Fed has crushed bond income for insurers.  According to Bloomberg, 2015 investment income at North American insurers dropped below 2011 levels.

Insurer Yields

 

Unsurprisingly, in their stretch for yield, insurers added to energy bond positions in 2015 to offset the funding gap.  Now, the collapse of oil prices has apparently left North American life insurers in a bit of a pickle with distressed debt holdings having doubled in a matter of 6 months as IG energy bonds turned to junk. 

North American life insurers have accidentally doubled their distressed-debt holdings in just six months. In the future, they are poised to build on that mound by design.

 

Companies including Prudential Financial Inc. and MetLife Inc. held $1.32 billion of bonds that were in default, or close to it, at the end of the second quarter, their highest level since the middle of 2011, according to Bloomberg Intelligence data.

 

They did not intend to buy distressed debt: In many cases they bought investment-grade bonds from energy drillers and retailers that ended up heading south. Insurance companies’ trouble with these bonds underscores how even conservative investors have been hurt by plunging oil prices.

Energy Risk

Per a portfolio manager at Prudential, energy bonds appeared cheap back in 2014 due their conservative debt-to-asset ratios.  Well, that's probably true if you just assume that prevailing market prices for commodities are right and ignore long-term supply/demand fundamentals.

Energy bonds looked fairly safe to many insurers because oil and gas companies had high levels of assets relative to their debt, according to Mike Collins, a portfolio manager at Prudential’s fixed income unit, which oversees $652 billion for external investors. But as oil prices have plunged, so has the value of the assets, and the bonds have proven to be far riskier than they appeared, Collins said. He was speaking generally and not about Prudential in particular.

 

“I don’t think anybody expected oil to fall as much as it did,” Collins said, referring to the price of a barrel of oil, which plunged from more than $100 in 2014 to less than $26 in February. “That caught a lot of people by surprise, and a lot of companies have gone from looking like they’re in great shape to distressed very quickly."

But don't worry about the rising risk of bond portfolios at the insurers.  Regulators are already working on a plan to relax capital requirements to accommodate increasing risk appetites at America's insurers.  Guess moving down the quality curve is one way to combat a low-interest rate environment.

Even if distressed holdings are largely accidental now, regulators are considering proposals that could ease the amount of capital life insurers can use to fund junk bonds, which makes it more profitable for the companies to increase their investment risk. Life insurance companies are seeking more income as low bond yields globally corrode their investment returns.

 

Under current rules from the National Association of Insurance Commissioners, which sets standards for the U.S. industry, a bond with a rating four steps below junk needs to be funded with capital equal to at least 10 percent of the bond’s value before taxes. The NAIC is considering a proposal to lower that to around 6 percent.